Security Interests

A security interest is a method by which a supplier or financer can protect their interests in the equipment or goods until paid. It’s similar to a lien against the title to that item. It puts other parties on notice of that interest and makes any subsequent sale also subject to that claim. A buyer may also have what is called a Purchase Money Security Interest to the extent the supplier has taken or retained all or part of the price in the goods or equipment.

In the United States Article 9 of the “UNIFORM COMMERCIAL CODE - SECURED TRANSACTIONS; SALES OF ACCOUNTS AND CHATTEL PAPER” is the law that governs security interests. Security interests may be created by a separate agreement or the terms of an agreement could establish a security interest for the Supplier until the buyer makes complete payment.

Security interests are a form of credit protection where the seller is not relying upon only the credit of the Buyer but also wants to have the additional protection where other parties are put on notice of the fact that they have a legal interest in the item and as such the other party cannot transfer full interest or title to them until the security interest has been satisfied by payment and release of the interest.

In a number of negotiations I’ve dealt with suppliers that wanted to have security interests in the goods they sell until they receive payment. Assume you had sixty-day payment terms. What a security interest would do is prevent you from being able to sell the item you purchased for resale within that period with clear title. If you were using what you purchased in a higher level product what it would do is prevent you from selling that higher level product with clear title during that period. In these types of situations as a buyer it’s best to avoid providing a supplier with the right to have a security interest as it complicates the sales. It’s better to either make sure that they are willing to rely upon your credit ratings or even offer other assurances of payment if needed such as a letter of credit or bank guarantee. Situations where a security interest might be acceptable would be if you were purchasing a major piece of capital equipment under credit terms. In they situation where it is only for internal use, a cloud on the title in the form of the security interest would have no impact on your ability to use the equipment in the interim and it would protect the supplier against potential loss if your company were to file for bankruptcy.

Purchase Money Security Interests are provided for under the UCC and are restricted to goods and software. The advantage to a Buyer of establishing a Purchase Money Security Interest in goods or software, that they have paid for which have not been delivered, is in the event of Bankruptcy. Advanced payments are considered a form of financing and the UCC established PMSI as a super- priority that has precedence over other secured creditors. The priority in a bankruptcy would be first the payment of any taxes; then to any super-priority creditors; then to secured parties; then to ordinary creditors and lastly to any shareholders. So what a PMSI does is place you below any government claims for taxes, equal to other super-priority creditors and above secured creditors and unsecured creditors.

For paid finished goods being held at the Supplier, you would not rely upon a PMSI. Rather, once payment has been made they should be treated as goods that you own that are being consigned to them and have language in the agreement that establishes the consignment and their responsibilities as the consignee. The reason for that is simple, in the event of bankruptcy you as the consignor of the goods own them. As the owner you would have the right to enter the supplier’s premises to recover your owned material that is consigned to them. PMSI gives you a higher place in the line of creditors where you may be able to get the goods or recover some of the monies paid if there are any after taxes are paid and as long as other super-priority creditors get the same according to their share, whereas consignment allows to fully recover the goods.